By: Randall A. Denha, J.D., LL.M.
As the name implies, a single-member LLC is simply a limited liability company with one owner (member), instead of multiple owners. Under current IRS rules, unless the single member LLC elects to be treated as a corporation, it is disregarded for Federal income tax purposes. That means if the only member is an individual, all of the income and expenses of a business operated as a single member limited liability company will be reported on a Schedule C attached to the individual’s Form 1040. If the single member is a corporation or partnership, the single member LLC’s income and expenses will be aggregated with the other income and expenses of the corporation or partnership and reported on that entity’s tax return. The following are the advantages and disadvantages of a single member limited liability company:
- Asset Protection. A single-member LLC “may” act as a shield to protect your personal assets from the liabilities associated with the business conducted by the LLC. For example, if your LLC owns a rental property, and someone slips and falls on that property and wants to sue the property owner, that plaintiff will be required to sue the LLC, not you personally. If the plaintiff ultimately wins the lawsuit, he or she will only be able to come after the assets owned by the LLC, not the LLC owner. The same protection applies to protect the owner from any debts of the LLC.
- Disregarded Entity Tax Status. As stated above, a single-member LLC will be treated as a “disregarded entity” for federal income tax purposes (unless it formally elects to be treated as a corporation), and thus its profit or loss will be reported on an individual member’s Schedule C as if it were a sole proprietorship. This will save the member time and money in connection with the preparation of income tax returns, since the separate LLC entity need not file any tax return.
- Ease of Use. There are very few legal requirements when it comes to running an LLC. The state will not require you to file annual reports or annual minutes. You really don’t have to keep any minutes at all. However, beware of this potential trap! See the list of “disadvantages” below to see how to avoid this problem.
- There are two cases, one a federal bankruptcy case and the other an employment tax liability case that deal with liability of a member in an LLC. In Re Ashley Albright and Littriello v. United States, et al., remind us that proper asset protection planning, especially in the design of an LLC, is a necessity and without it the consequences may be disastrous. These cases are important because courts are beginning to view a single-member LLC as a disregarded entity under multiple scenarios in some states. Albright was a federal bankruptcy case where the entity was disregarded and Littriello was an employment tax liability case where the entity was again disregarded and the owner, Littriello, was found liable for the entity’s taxes. In Littriello, the taxpayer was found liable for the entities liabilities and was treated as a sole proprietor.
In Littriello, what the taxpayer wanted to do was avoid the double taxation of a C-Corporation while trying to maintain the asset protection features that come along with owning a business as an LLC. The mistake in the Littriello case that the member failed to realize was that a single-member LLC without the proper election to an S-Corporation results in the entity defaulting to the status of being a sole proprietorship. As a sole proprietor, the owner of the LLC has personal liability for all of the entity’s liabilities. In other words, had he or his CPA or attorney filled out form 2553 (“check the box”) to have the LLC treated like an S-Corp., he could have avoided personal liability for the entity’s liabilities and some amount of employment taxes for any “distributions” he takes from the entity each year.
- Keep Good Records and Stay Awake at the Wheel. Since little is required, most people do almost nothing in regard to keeping records of actions taken by the LLC. In many cases, they don’t even have an Operating Agreement, which is the bylaw of the LLC and dictates how the company will function. In such situations, the plaintiff in a lawsuit against the LLC will ask the judge to set aside the asset protection associated with the company by claiming the company is a sham since it has no records and no Operating Agreement. In some cases, the court may agree and the single member could become personally liable for the business debts. This potential disaster can be avoided through good corporate governance and annual maintenance.
- Lack of “Outside” Liability Protection. Courts in a variety of states have “pierced the veil” of a single-member LLC from the outside and have held that it is not a separate entity and thus may not be used to protect the assets of the LLC from the creditors of the member. For example, assume you get into a car accident texting and you get sued in excess of your insurance policy. Can the plaintiff come after your rental property in an LLC? The law says in many states state that if your LLC is owned by 2 members, they can’t pierce the LLC. However, only a handful of states give the single-member LLC the same protection as a Multi-Member LLC (Wyoming, Nevada and Delaware). Thus, the Single-Member LLC in the far majority of states will not protect against personal liability in the event of a lawsuit or other claim. In order to avoid this issue, you can do one of two things: (i) create at least a two-member LLC (highly recommend!) with sufficient legal documentation (including an operating agreement and annual company minutes, etc.) to reflect that the two-member LLC is indeed a separate entity and has been treated as such; or (ii) set up a holding or parent company in Wyoming, Nevada or Delaware to own your other LLC’s.
Where do they work best?
- For those with a brand new rental property. A single-member LLC is a great place to start if you just bought your first rental property, or really only have a few rentals. As the number of your rental properties grow, and maybe even located in several states, setting up a multi-member LLC or multi-entity structure is something you can easily expand into. Remember, the benefit of an LLC is their flexibility and the ability to expand and grow your asset protection structure as your wealth increases.
- Multi-Entity Structuring. You may want to set up a multi-member ‘Parent’ or ‘Holding LLC’ that owns your other single member LLCs in the same state or other states. This allows for a consolidated tax return (saving on tax prep fees), but gives you the inside and outside protection with multiple buckets all flowing back into one entity.
- The Operational Business Start-up and Convert to S-Corporation Later: One idea is to start your ‘operational’ business as a Single-Member LLC and graduating to an S-Corp (with a simple S-Election) when your income reaches a certain level. For example, rather than wait to set-up an S-Corp when it could be too late and cost you Self-Employment tax, start as a Single-Member LLC and then you can make a retroactive S-Election to the LLC after you see the net-income and implement the salary/dividend split of the S-Corp without paying any Self-Employment tax. If you don’t make the income, at least you have the some of the asset protection of the Single-Member LLC (subject to state law) and could even start building corporate credit under the EIN of the LLC.
While effective in several situations, a single-member LLC is not a silver bullet that will cure all potential asset protection and tax planning problems. There are many options but the Single-Member LLC could provide just the right weapon in your arsenal. It’s important to sit down with a competent legal and tax help to create a solution that is right for you and your goals.